Purchasing refers to a business or organization attempting to acquire goods or services to accomplish the goals of the enterprise. Though there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between organizations. Typically the word “purchasing” is not used interchangeably with the word “Procurement”, since procurement typically includes Expediting, Supplier Quality, and Traffic and Logistics (T&L) in addition to Purchasing.
Purchasing function, in a business environment, is one of the most critical functions as it provides the input for the organization to convert into output. Materials today are lifeblood of industry. They must be available at the proper time, in the proper quantity, at the proper place, and the proper price. Company costs and company profits are greatly affected by them as normally, a manufacturing organization spends nearly 50% of its revenue in purchasing.
Purchasing managers/directors, and procurement managers/directors guide the organization’s acquisition procedures and standards. Most organizations use a three-way check as the foundation of their purchasing programs. This involves three departments in the organization completing separate parts of the acquisition process. The three departments do not all report to the same senior manager to prevent unethical practices and lend credibility to the process. These departments can be purchasing, receiving; and accounts payable or engineering, purchasing and accounts payable; or a plant manager, purchasing and accounts payable. Combinations can vary significantly, but a purchasing department and accounts payable are usually two of the three departments involved.
Historically, the purchasing department issued Purchase Orders for supplies, services, equipment, and raw materials. Then, in an effort to decrease the administrative costs associated with the repetitive ordering of basic consumable items, “Blanket” or “Master” Agreements were put into place. These types of agreements typically have a longer duration and increased scope to maximize the Quantities of Scale concept. When additional supplies are required, a simple release would be issued to the supplier to provide the goods or services.
Another method of decreasing administrative costs associated with repetitive contracts for common material is the use of company credit cards, also known as “Purchasing Cards” or simply “P-Cards”. P-card programs vary, but all of them have internal checks and audits to ensure appropriate use. Purchasing managers realized once contracts for the low dollar value consumables are in place, procurement can take a smaller role in the operation and use of the contracts. There is still oversight in the forms of audits and monthly statement reviews, but most of their time is now available to negotiate major purchases and setting up of other long term contracts. These contracts are typically renewable annually.
This trend away from the daily procurement function (tactical purchasing) resulted in several changes in the industry. The first was the reduction of personnel. Purchasing departments were now smaller. There was no need for the army of clerks processing orders for individual parts as in the past. Another change was the focus on negotiating contracts and procurement of large capital equipment. Both of these functions permitted purchasing departments to make the biggest financial contribution to the organization. A new terms and job title emerged –Strategic sourcing and Sourcing Managers. These professionals not only focused on the bidding process and negotiating with suppliers, but the entire supply function. In these roles they were able to add value and maximize savings for organizations. This value was manifested in lower inventories, less personnel, and getting the end product to the organization’s consumer quicker. Purchasing manager’s success in these roles resulted in new assignments outside to the traditional purchasing function – logistics, materials management, distribution, and warehousing. More and more purchasing managers were becoming Supply Chain Managers handling additional functions of their organizations operation. Purchasing managers are not the only ones to become Supply Chain Managers. Logistic managers, material managers, distribution managers, etc all rose the broader function and some had responsibility for the purchasing functions now. In accounting, purchases are the amount of goods a company brought throughout this year. They are added to inventory. Purchases are offset by Purchase Discounts and Purchase Returns & allowances.
When it should be added depends on the Free O n Board (FOB) policy of the trade. For the purchaser, this new inventory is added on shipment if the policy was FOB shipping point, and the seller remove this item from its inventory. On the other hand, the purchaser added this inventory on receipt if the policy was FOB destination, and the seller removes this item from its inventory when it was delivered.
Goods brought for the purpose other than direct selling, such as for Research & Development, are added to inventory and allocated to Research and Development expense as they are used. On a side note, equipments brought for Research and Development are not added to inventory, but are capitalized assets.
Purchase Procedure
A typical purchase department is usually engaged in purchasing a number of materials and services falling in different categories. The activities are performed regularly by purchase professionals with the objective of fulfilling organization’s materials and services needs.
Naturally, depending upon the nature of procurement, environmental practices etc the purchasing systems and procedures may also vary substantially. However, purchase procedure can be seen to have a bit of standardization across the globe and therefore a professional purchasing system does show following steps that eventually constitute a purchasing cycle:
- Recognition & description of need
- Transmission of need
- Selection of source to satisfy the need
- Contracting with the accepted source
- Following up with the source
- Receiving and inspecting material
- Payment and closure of the case
Procurement activities in an organization start right since the stage a need is felt for any material or service.
An organization categorizes its material requirements into two broad ways, viz. Inventory Control item or Non inventory item.
A department within the organization may require an item which is non inventory and thus the department concerned shall have to describe the need.
It implies writing down the specification of the item, the volume (quantity) etc of the item and some other related information to process it further.
For an Inventory item, usually, there is a forecasting method by which the need for an item is addressed
What could be a need?
The need for an item may be at regular interval, one time or even be sporadic in nature. This could be an item needed for running a machine, certain raw material needed for production, a service in terms of maintenance of a machine or for doing certain job needing the employment of labor, materials, machines etc.
Purchasing Function vs. Purchase department
Purchasing function is a function commonly seen in all those organizations that undertake purchasing activities. Purchase department is a unit of an organization that performs purchasing function. The purchasing function is usually performed by a specialized and centralized purchasing department, directed by an efficient manager to achieve the performance in an economical manner.
Profit making Centre
Purchasing is responsible for spending nearly half of a company’s income for buying the input materials. Obviously, any saving achieved by it results into direct saving for the company and all such savings are a company’s profit Going by a thumb rule “even 1% saving achieved in Purchasing results in 5% profit for any organisation”.
Procurement vs. Purchasing
It is used to define one of several supply functions involved in logistics activities. In the broadest sense procurement includes the entire process by which all classes of resources (people, materials, facilities and services) for a particular project are obtained. Since purchasing is a unique function, it differs a bit from procurement in the sense that while procurement, with the same objective has a wider domain, purchasing with the same objective is included in it!
Objectives of Purchasing
The classical definition of objectives of purchasing is to buy materials and services of the right quality, in the right quantity, at the right place, from the right source and at the right time. However, in general management parlance the objectives of purchasing are:
- To support company operations with an uninterrupted flow of materials and services.
- To buy competitively and wisely
- To help keep a minimum Inventory
- To develop reliable alternate sources of supply
- To develop good vendor relationship and a good continuing supplier relationship
- To achieve maximum integration with the other departments of the firm
- To train and develop highly competent personnel
- Who are motivated to make the firm as well as their department succeed
- To develop policies and procedures which permit accomplishment of the preceding seven objectives at the lowest reasonable operating cost
The basic objective, in pure practical terms is, of course, to derive the maximum value for each unit of currency spent in buying. Purchase is no doubt a vast subject & as the competition among the firms is grow this function of business an expected to see a lot of evolution.
Types of purchasing
Considering the nature of business an organization has there could be different approaches & hence purchasing can be any of these types:
- Forward purchasing
- Tender purchasing
- Speculative purchasing
- Rate Contract
- Reciprocity
- Zero store buying
- Blankest order
- Forward Buying
Forward Buying as the name suggests is the system under which buying is done with longer term in perspective. It is not meant for meeting the present consumption requirement. It is rather a commitment on part of both the buyer and the seller, normally for a period of one year. Depending upon the availability of the item, the financial policies, the economic order quantity, the quantitative discounts, and the staggered delivery, the future commitment is decided. A few organizations do “hedge”, particularly in the commodity market by selling or buying contracts. Forward buying helps a firm in booking capacity of a supplier and thus often results into a safeguard against a competitor acquiring his capacity.
It is usually done for Raw materials but is not limited to it. Now a days, with competition becoming globalize such an arrangement is a win-win situation for both, the buyer and the supplier.
Tender Buying
Purchasing through tendering is most common in government and public sector buying where besides restricted expenditure on buying transparency in the buying process also is important. Tender basically is the quotation submitted by the interested vendors against Tender notices which are invitations extended to the prospective vendors to quote for the given material depending upon situations, tendering too has various modes that is types.
Open Tender: In a situation where the sources of supply that is vendors are not known or there are likelihood of getting more responses from unknown sources then open tendering is resorted to. This is done through large scale reachable media such as Internet, Newspapers or leading trade journals.
Systems Contracting
Systems contract, as the term suggest, is a contract of system of buyer with that of the seller. It is a release system in which items, usually, commonly available off-the-shelf, are identified and pre-priced in anticipation of certain usage. Delivery releases are made against existing orders placed by purchase. This is a procedure intended to help the buyer and the seller to reduce administrative expenses and at the same time to ensure proper controls. The system authorizes the designated persons of the buyer to place orders directly to the supplier with the specific materials during a given contract period. The contract is thus finalized only after it is ensured that an attempt has been made to integrate as many buyer-seller materials management functions as possible.
In this system the original indent, duly approved by competent authorities, is shipped back with the items and avoiding the usual documents like purchase orders, materials requisitions, expediting letters and acknowledgements, goods in transit report, etc. The contract is simple, covering only delivery period, price and invoicing procedure. Systems contracting are particularly useful for items with low unit price and high consumption profile and thus relieve the buyers of the routine work.
While Systems contract has certain features in common with other purchasing agreements, it is this integration of buyer-seller operations that clearly distinguishes it from other types of contracts.
Speculative Buying
When purchasing is done purely from the point of view of taking advantage of a speculated rise in price of the commodity it is called Speculative buying. The intent is not to buy for the internal consumption but to resell the commodity at a later date when the prices have gone up and to make a profit by selling. The items may be those that are needed for internal consumption but the quantity shall be much more than the requirement so as to take advantage of the coming price rise.
Rate Contracts
Rate contracts are mutual agreements between the buyer and the seller to operate a set of chosen items, during a given period of time, for a fixed price or price variation. Under this system the rates are fixed and at times even the quantity of the selected items. As and when the need arises the buyer issues a Purchase order directly on the basis of the rate chart available on the supplier who in turn supplies the items.
The system of rate contract is prevalent in public sector organist ions and government departments. It is common for the suppliers to advertise that they are on “rate contract” with the DGS & D (Directorate General of Supply & Distribution), for the specific period the given items. After negotiation, the seller and the buyer agree to the rates of items. Application of rate contract helps organizations cut down the internal administrative lead time as individual firms need not go through the central purchasing departments and can place orders directly with the suppliers.
However, suppliers always demand higher prices for prompt delivery, as rate contracts normally stipulate only the rate and not the schedule on which the item is needed. This difficulty has been avoided by ensuring the delivery of a minimum quantity at the agreed rates. This procedure of fixing a minimum quantity is called the running contract and is being practiced by the railways and he DGS&D.
Reciprocity in Buying
In certain business situations a buyer may give preference to a supplier who also happens to be his customer. This relationship is known as reciprocity. It is something like “I buy from you if you buy from me”
One of the main questions for which this, otherwise simple way of buying, is always under the scanner of purchasing ethics is its undue ability to restrict competition and fair play. One of the major roles that any purchaser plays for his firm is in cost reduction arena which is attempted by generating competition among the suppliers. This principle gets a jolt through reciprocity in buying. However, when factors such as quality, after sales service, prices etc are equal normally a buyer would like to buy from his customer, if for nothing then at least for having a good working relationship. However, the distinct disadvantages of reciprocal buying outweigh the limited and narrow advantage that a firm may out of it.
A purchasing executive should not indulge in reciprocity on his initiative when the terms and conditions are not equal with other suppliers. It is often found that less efficient manufacturers and distributors gain by reciprocity what they are unable to gain by price and quality. Since this tends to discourage competition and might lead to higher prices and fewer suppliers, reciprocity should be practiced on a selective basis.
Zero Stock Buying
Zero Stock Buying refers to buying in a manner that the system ensures that the material is delivered by the seller only when it is required and that no prior inventory of the item is maintained by the buyer. As the competition becomes more intense the need for a lean manufacturing system becomes more focused. Keeping inventory thus is blocking huge money that is idle for the firm. Thus Zero stock buying is more of an inventory safeguard rather than the normal buying.
Normally, under this system the firms try to operate on the basis of zero stock and the supplier holds the stock for these firms. Usually, the firms of the buyer and seller are close to each other so that the raw material of one is the finished product of another. Alternatively, the system could work well if the seller holds the inventory and if the two parties work in close coordination. However the price per item in this system is slightly higher as the supplier may include the inventory carrying cost in the price. In this system, the buyer need not lock up the capital and so the purchasing routine is reduced. This also significantly reduces obsolescence of inventory, lead time and clerical efforts in paper work.
For example, in India, say the Indian Oil Limited maintains its petrol and diesel refilling stations inside the manufacturing premises of many companies. As and when petrol or diesel is required, say in a lorry, IOL fills that and a coupon is signed by the driver of the lorry. Buyer makes the payment to IOL against that coupon.
Blanket Orders
Under this system an agreement is done between the buyer and the supplier to provide a required quantity of specified items, over a period of time, usually for one year, at an agreed price. This system minimizes the administrative expenses and is useful for ‘C’ class items for which rigid controls are not required. Deliveries are made depending upon the buyer’s needs. The system relieves the buyer from routine work, giving him more time for focusing attention on high value items such as ‘A’ and part of ‘B’ class. It requires fewer purchase orders and thus reduces clerical work. It often achieves lower prices through quantity discounts by grouping the requirements. The supplier, under the system, maintains adequate inventory to meet the blanket orders, but he does not incur selling costs, once the negotiations are finalized.
